The structure of home mortgages varies around the world. Paying for mortgage points is a common practice in the United States and, at least according to anecdotal evidence, it may be a uniquely American approach to home financing. In this article, we’ll discuss the different mortgage points and how to make them work for you.
What Mortgage Points Are
Mortgage points come in two varieties: origination points and discount points. In both cases, each point is equal to 1% of the total amount mortgaged. For example, on a $100,000 home, one point is equal to $1,000. Origination points are used to compensate loan officers. Not all mortgage providers require the payment of origination points, and those that do are often willing to negotiate the fee. Origination points are not tax deductible.
Discount points are prepaid interest. The purchase of each point generally lowers the interest rate on your mortgage by 0.25%. Most lenders provide the opportunity to purchase anywhere from zero to three discount points. We will focus mainly on discount points and how they can decrease your overall mortgage payments. It is important to note; however, that when lenders advertise rates, they often show a rate that is based on the purchase of points. If you itemize your taxes, discount points are tax deductible on Schedule A.
Should You Pay For Points?
The decision of whether or not to pay for points focuses on discount points and requires being able to understand the mortgage payment structure. There are two primary factors to weigh when considering whether or not to pay for discount points. The first involves the length of time that you expect to live in the house. In general, the longer you plan to stay, the bigger your savings if you purchase discount points. Consider the following example:
On a $100,000 mortgage with an interest rate of 6%, your monthly payment for principal and interest is $599.55 per month.
With the purchase of three discount points, your interest rate would be 5.25%, and your monthly payment would be $552.20 per month.